07/23/2013 03:23 EDT | Updated 09/22/2013 05:12 EDT

Moody's likes the outlook for Canadian supermarkets

Canadian supermarkets are doing better than their U.S. and European counterparts in maintaining profit margins and credit quality, according to a Moody's analysis released Tuesday.

The credit rating agency does not usually look at the big three Canadian grocers — Loblaw Companies Ltd., Empire's Sobeys and Metro Inc. – but was asked for its opinion in the wake of Loblaw’s $12.4-billion merger with Shoppers Drug Mart and Sobey’s $5.8-billion acquisition of Canada Safeway.

"Our main finding is that although the Canadians are smaller and less diverse, they have good margins and superior credit metrics," Moody’s said.

It had a generally beneficial view of the Loblaw's takeover, saying the company’s debt load will rise following the Shoppers deal, but should come down within two years. Loblaw will pay for Shoppers in cash and stock.

Moody's called the merger "complementary" and predicted Loblaw will see sales grow, especially in health and wellness products, following the acquisition.

The three Canadian supermarket chains compare well with European stores, which are seeing margins flatten and earnings shrink, despite being larger and offering a more diverse range of products.

Comparable European supermarkets — Tesco PLC, Carrefour S.A., Koninklijke Ahold N.V. and Delhaize Group – are exposed to non-food products, such as clothing and consumer electronics, which has left them vulnerable to the economic downturn, Moody’s said.

The European grocers lag behind their American and Canadian counterparts in terms of same-store sales growth, it added.

America in the middle

U.S. supermarkets are seeing stronger same-store growth, but are in a more competitive market, with flatter margins.

Moody’s estimates Metro leads the Canadian grocers with a profit margin of nine per cent of earnings before certain Items. That compares to 7.5 per cent at Sobeys and 7.0 per cent at Loblaw.

It says the expansion of Wal-Mart and Target into Quebec could squeeze Metro's profit margins but believes all three chains can weather the competition.

"We think the Canadian supermarkets' margins are somewhat protected to the downside by ongoing cost reduction measures, tight inventory management, improving store offerings and an increased focus on loyalty programs."

"We expect the impact of rising competition to be manageable for the Canadians and that their aggregate margins will be better than those of the Europeans in the medium term."